Ok, sports fans, the Street’s most celebrated analyst is out with his 2019 outlook and for those of you who are reasonably constructive on equities headed into the new year, there’s a lot to like.
The bottom line is that JPMorgan’s Marko Kolanovic is headed into 2019 long equities and underweight bonds. He sees S&P EPS growth running at 8% in the new year and his S&P target is 3,100.
The economic rationale is straightforward. “We base our market outlook on the view that the business cycle will not end in 2019”, he says, before reminding you that “historically, equity markets peak several months before a recession, and to assume that market already reached cycle highs would likely mean that the recession needs to start around now.”
That, Kolanovic contends, is “practically impossible” considering where consumer spending and PMIs are and also accounting for still healthy corporate profit growth.
Beyond that, Kolanovic’s assessment is couched in terms of “reality” versus what he pretty clearly believes is a combination of excessive pessimism and outright fiction.
“Positive GDP and earnings are ‘reality,’ which is currently starkly disconnected from equity sentiment, valuation, and positioning”, he writes, on the way to flagging 12M forward P/E estimates which have fallen to near five-year lows and low exposure from both the discretionary/fundamental crowd and systematic strats.
Marko then poses the following question:
Why is there such a disconnect between strong fundamentals and valuations/positioning, and what is driving it?
If you’ve been following along, you probably know at least part of the answer.
At this juncture, I think it is entirely fair to say that Kolanovic is not amused with the rampant dissemination of misinformation, both market-related and otherwise. He’s been hinting at this for months and earlier this week, in a quick note, he reiterated his consternation.
In his 2019 outlook, Marko expands on the point – a lot.
After noting that it is natural for volatility to rise and for credit spreads to widen as monetary policy tightens and central bank accommodation is gradually rolled back, Kolanovic delivers his most pointed critique yet of how misinformation is disseminated to market participants. Here is his assessment:
For instance, there are specialized websites that mass produce a mix of real and fake news. Often these outlets will present somewhat credible but distorted coverage of sell-side financial research, mixed with geopolitical news, while tolerating hate speech in their website commentary section. If we add to this an increased number of algorithms that trade based on posts and headlines, the impact on price action and investor psychology can be significant.
What investors should understand – and we’ve been pounding the table on this for the better part of two years – is that misinformation, when disseminated by widely-read sources, has the potential to seriously undermine markets and because algos have no way to assess the credibility of a given headline or otherwise discern whether a given move in markets is at least partially attributable to traders acting on the same misinformation, the deleterious effect is amplified.
And oh, the irony. Because some of the same portals who spread misinformation have for years bemoaned the effect of algorithmic trading on liquidity. Now, some of those same portals are effectively making things worse.
Kolanovic goes on to note that the incessant barrage of tweets and caustic commentary from the Trump administration only adds to the confusion.
“The current US administration has also given more than enough material (e.g., tweets, etc.) to be exploited by these actors in order to create an environment of investment uncertainty (e.g., on issues of global trade, oil, business decisions of individual companies, etc.)”, he writes.
You might recall how, on Wednesday evening when S&P futures crashed, we suggested that in and of itself, the Huawei news couldn’t/shouldn’t have caused such a dramatic drop.
While other portals were busy screaming from the rooftops about Huawei, we suggested that between that screaming and a lack of market depth/liquidity, the story became a self-fulfilling prophecy.
Marko underscores that assessment – and then some.
“An example of the negative impact of carefully timed news stories is the recent episode with the arrest of Huawei’s CFO during the market holiday overnight session, which disrupted futures trading”, he writes, just after discussing how misinformation proliferates through the financial blogosphere. Here, for those who need a refresher, is how we described the same dynamic on Wednesday:
While we would caution that it’s too early to draw conclusions about whether and to what extent the news will seriously undermine U.S.-China relations barely five days on from the tentative trade truce struck in Argentina, we’d be remiss not to note that this kind of thing has a way of becoming self-fulfilling when markets are already on edge.
That is, two ostensibly unrelated events can end up becoming inextricably intertwined simply because enough people start to believe that they actually were related.
U.S. equity futures crashed out of the gate on Wednesday evening and it was by no means clear that the dramatic gap lower was entirely (or even partially) attributable to news that Canada has arrested Huawei Technologies CFO Wanzhou Meng.
The worry is that while the initial knee-jerk lower in U.S. equity futures might not have had much to do with the Huawei news, the fact that the story has now been widely cited as a possible contributing factor could cause traders to pull back or, worse, turn bearish.
That’s what Kolanovic means and we flagged it immediately with the Huawei story.
Moving on to liquidity, Marko delivers an updated assessment of the commentary we included in the above-linked S&P futures crash post.
“With higher interest rates, there are also real structural risks that are significantly higher this year the most prominent one is the decline of market liquidity, as provided by electronic market makers”, Marko says, echoing a theme that has pervaded his research for years. The following chart (left pane) shows S&P futures liquidity falling to an all-time low.
“Lower liquidity is largely a result of higher volatility and higher interest rates”, Kolanovic says, adding that “in an environment of poor liquidity, any market move will be amplified, thus creating a positive feedback loop between volatility, liquidity, and the news cycle.”
In addition to everything flagged above, Marko cites the following risk factors for the new year (and this is a truncated/abbreviated list):
- residual risk coming from global trade frictions
- equity markets can absorb one or two more hikes, but could come under increasing pressure beyond that
- it is virtually certain that US political divisions will introduce additional market volatility in 2019
- political issues in Europe will persist for a while, but in the end they have to be resolved in the best interest of all parties
Finally, Marko beautifully summarizes populism in its current incarnation which, as we never tire of reminding readers, is a kind of caricature of historical analogs, an amusing state of affairs considering that populism is itself inherently farcical to the extent the plot can almost never be taken seriously. Here’s Kolanovic:
Negotiations and frictions are part of populist theatrics and will be used by politicians for self-promotion, often bringing everyone to the edge. Yet we believe that these new age populists do not have broad enough support or conviction to cause the type of disasters that we witnessed in the 20th century.
Here’s hoping, Marko – here’s hoping.